OPEC: New and Improved?

Smaller producers are eager to work with OPEC or join the cartel in an effort to boost their reputation, amplify their market clout, and gather research, information, and resources to attract investment.

The Republic of the Congo produces only about 300,000 barrels per day (b/d) of crude, but its desire to join OPEC is telling. The African country’s request to enter the organization reflects OPEC’s reestablished influence and shows how smaller producers are eager to work with OPEC or join the cartel in an effort to boost their reputation, amplify their market clout, and gather research, information, and resources to attract investment.

Congo’s request comes after Equatorial Guinea became an OPEC member last year, Gabon rejoined in 2016, and the cartel was able to bring ten non-OPEC producers into its 2016 production cut agreement. Total production capacity of participants in the 1.8 million barrel-per-day (mbd) supply cut represents approximately 55 percent of the world’s total output.

If Congo is admitted, seven producers from Africa—five from the sub-Saharan part of the continent—would be OPEC members, while Sudan and South Sudan are included as part of The Vienna Group. (Uganda said it will seek OPEC membership in 2020 when it starts producing oil). Outside of Nigeria and Angola, the sub-Saharan producers are relatively small with total production of less than one million barrels per day (mbd). Congo’s production has rebounded over the past decade thanks to higher investment, and the country is poised to reach 350,000 b/d this year. European oil companies ENI and Total have undertaken large projects in the country, which has approximately 2 billion barrels of reserves and is the fifth largest producer in sub-Saharan Africa.

One benefit of Congo joining OPEC is the opportunity develop ties with the cartel’s members. The interests of smaller players are closely aligned with established members: They need higher prices to support their economies, reduce debt, and handle unrest. Crucially, membership provides a seat at the discussion and decision table when the group analyzes market trends, swaps information, and develops production policy. During the downturn of 2014-16, smaller producers were blindsided by the velocity of the price fall, and their own analysis of the situation was inadequate, providing motivation to establish dialogues with other oil-producing nations. For the smaller players, membership also offers greater international profiles, which would be difficult to achieve without a relationship with OPEC.

For OPEC as a whole, more members, along with increased coordination with non-OPEC countries, lend legitimacy to the organization. Larger producers—most notably Saudi Arabia—can spread responsibility for price volatility and anti-competitive actions. Adding members—even ones as small as Congo, Gabon, and Equatorial Guinea—also incrementally increases OPEC’s market share. Congo joining would increase total membership to 15 and overall production capacity to approximately 36 mbd, combating the widely believed narrative a few years ago that OPEC is “dead” and its market power had waned. “OPEC is a fluid organization, changing when it needs to,” one market source told The Fuse. “Expect more emerging African producers to want to join.”

OPEC trying to adjust to 2018

OPEC members are suddenly contending with a problem they did not think they would face—prices are too high for their comfort. The cartel’s production cuts successfully reduced inventories over the past year; the group has stuck to compliance targets; demand continues to grow at a strong pace; and Venezuela’s output is declining faster than expected due to instability. ICE Brent is trading at $70 per barrel, and this level could lead to a quick increase in U.S. shale supplies or OPEC members cheating on targets for more revenue, possibly precipitating a sharp price reversal. Alternatively, oil markets could rise even more if inventories continue to decline and Venezuela’s output falls further. Neither one of those situations is ideal for the cartel.

OPEC members are suddenly contending with a problem they did not think they would face—prices are too high for their comfort.

This is where not having a credible and cohesive exit strategy looms over members. Although OPEC has revamped its image as a market manager to increase prices, market participants remain skeptical that it can provide stability. If prices remain near current levels, members will have to wind down the agreement in a credible way before higher prices occur. But if the deal ends in an abrupt way and members flood the market all at once, speculators may sell off sharply.

Over the weekend at the Joint OPEC/Non-OPEC Ministerial Monitoring Committee, oil ministers acknowledged their dilemma, but so far they have not formed a consensus on what strategy to take beyond 2018. In a joint interview, Saudi Energy Minister Khalid Al-Falih and Russian Minister Alexander Novak said their countries were discussing a smooth exit from the deal, but they did not give an exact timeframe and hinted supply cuts could last into 2019. The lack of a consensus guarantees OPEC ministers will use verbal intervention in coming months to manage expectations and manipulate market sentiment.

One major takeaway from recent developments is that Russia and Saudi Arabia—currently the two largest crude producers—have deepened their energy ties and will continue to do so for the foreseeable future.

It is uncertain what the final outcome of the OPEC deal will be, but one major takeaway from recent developments is that Russia and Saudi Arabia—currently the two largest crude producers—have deepened their energy ties and will continue to do so for the foreseeable future. Novak said Russia is prepared to cooperate with OPEC even after the cuts expire, and al-Falih confirmed that his country wants the alliance with Russia and other non-OPEC allies to continue. Some in the industry believe the Russia-Saudi link will indeed persist. “I think there is a general view out there that this is a convenient relationship for a short period of time. I actually don’t subscribe to that,” BP CEO Bob Dudley recently told Axios. “I think you’ll always have debates among OPEC nations and in Russia itself, but I think the cooperation around this, which is so vital to all the countries, I think they will remain more open and closer than what I would say is conventional wisdom.”

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.